Friday, March 12, 2010

Why Do Traders Lose Money in Slow Markets?

I've encountered many traders who make money in high volatility markets and then stop making money in low volatility environments.

Why does this happen?

Perhaps patterns change in the markets: how setups act during one volatility regime could be different from how they act in a different market environment.

Perhaps the traders are trading volatility expansion and not simply price movement. When the expansion doesn't occur, they lose opportunity.

Perhaps the traders are poor at execution. They can lose ticks on entering and exiting when trading ranges are large and still make money. When they lose those ticks in a narrow range environment, however, they no longer have an edge.

Perhaps slower markets display greater degrees of mean reversion than more active markets due to the dominance of market makers in slow markets. When traders play for trending or momentum, they find themselves quickly stopped out when mean reversion kicks in.

Perhaps traders lack discipline and trade slow markets as actively as they trade busy ones, failing to adjust stops and targets to the lower volatility of slow markets and thus getting stopped out before targets are hit.

In slow markets, I take profits opportunistically when my initial volatility-based targets are hit (see my Twitter posts for daily profit targets) and I trade less frequently given particularly narrow ranges midday. Personally, I find it better to size up one or two high probability trades early or late in the day than to seek setups throughout slow choppy action. The links below add perspective to this universal trading challenge.